Three cheers for Mr. Rosengren

The Federal Reserve Bank of Boston has been blessed with extraordinary leadership since the 1960s, if not longer. Eric Rosengren has continued that tradition since he became president of the bank in 2007. Now he is speaking out calmly and intelligently about the state of the economy and the need for his Federal Reserve colleagues in Washington to take greater action to accelerate economic growth. With the domestic economy’s annual growth rate slowing to 1.5 percent this past spring, the national unemployment rate rising to 8.3 percent, and Europe’s economy on the brink of another deep recession, Rosengren is urging the Fed to keep interest rates low by aggressively buying up bonds – possibly trillions of dollars of them.

In particular, the Boston Fed President would like to see the Fed buy mortgage securities in order to lower home loan rates further. This would make it possible for more households to refinance their mortgages at lower rates, leaving them with additional money each month to purchase other goods and services. It would also encourage renter households with good credit ratings to purchase homes, encouraging more housing construction. Lower interest rates would likewise help families pay off credit card debt. Interest rates are already at an all-time low, but driving them down further could spur at least a bit more investment activity.

If all of this were to happen, increased demand for all kinds of products and services could spur growth and the low interest rates would reassure businesses that they once again could think about investing in new productive capacity and hiring additional workers.

Mr. Rosengren’s call for such aggressive, proactive federal reserve bank policy is right on target because there are few options left and this is no ordinary time nor are we in a period of ordinary politics. Historically, at least since the Great Depression, the U.S. and most developed countries have relied on two types of public policies to stimulate the economy when growth slows and unemployment lines lengthen. The first is fiscal policy and it involves the federal government spending more or taxing less (or both) in order to create jobs through government contracts and grants or provide consumers with tax relief so they can purchase more goods and services – thus generating more employment. Indeed, this type of fiscal policy adds to the national deficit, but in times of high and rising unemployment it is appropriate to do so in order to keep the economy from sinking even further into recession. Once the economy is running at full throttle, it is appropriate to reverse fiscal policy and run surpluses that reduce these deficits. That is precisely what was done in President Bill Clinton’s second term. Through their power to tax and spend, the White House and the Congress are in charge of fiscal policy.

The second means of stimulating a weak or weakening economy is monetary policy. The Federal Reserve Board is the sole actor here. When the Fed buys bonds from the public, it drives down interest rates and puts cash back into the economy.

In normal times when there are just minor perturbations in the economy, we can rely on a modest dose of fiscal policy to tap one accelerator or a modest dose of monetary policy to tap on the other. If inflation begins to increase because the economy overheats, fiscal policy or monetary policy can be used to bring it under control by slowing spending, raising taxes, or raising interest rates.

In more dire times when the economy is plummeting into recession, it has been good practice to have fiscal policy and monetary policy both at work more aggressively – essentially having the White House, the Congress, and the Fed all hitting the accelerator until the private sector engine begins to surge and the public sector can let up on the gas pedal.

Right now is one of those times when we need those who control the fiscal side and those who manage monetary policy to work in tandem. And with interest rates already low, the fiscal side could pack a lot more punch. But just when we need it most, we are on the verge of abandoning fiscal policy altogether. Instead of using fiscal policy to stimulate the economy, Washington has decided to use it to reduce federal deficits. Already, a slowdown in spending by Congress (and by state and local governments which must balance their books on less revenue) amounts to tapping the brakes rather than the accelerator. Now if sequestration goes into effect in early 2013, billions of dollars more will be cut from federal budgets immediately and $1.2 trillion soon after. Instead of just stepping on the brakes, Washington will be stomping on them without the benefit of the anti-lock brakes on your automobile. Slamming on the brakes will almost surely throw the economy into a violent skid. Watch out for the ditch. Already there are reports that firms fearing sequestration are holding back from hiring new workers and some are planning layoffs.

This is why Mr. Rosengren’s pleading for Fed action is right on the money. Without fiscal policy and with the possibility of sequestration, all the work of spurring the economy now falls on the Fed. It must take prudent action. If the Fed does not act, essentially no one will. During the 1930s, New Deal fiscal policies saved the economy from even greater disaster when the monetary authorities were too timid. Today, with fiscal policy abandoned, the only hope might be that the monetary authorities in Washington listen to the leader of their Boston office.